reko international group inc. · reko international group inc. (the “ompany” or “reko”) is...

Reko International Group Inc.

Interim Condensed Consolidated Financial Statements (unaudited)

For the six months ended January 31, 2020 and 2019

Notice of No Auditor Review of Interim Condensed Consolidated Financial Statements The accompanying unaudited condensed interim consolidated financial statements of Reko International Group Inc. for the three months and six months ended January 31, 2020 have been prepared by Management and approved by the Board of Directors on March 5, 2020. The Company’s independent auditor has not performed a review of these interim condensed consolidated financial statements, in accordance with the standards established by the Chartered Professional Accountants of Canada for a review of interim financial statements by an entity’s auditor.

REKO INTERNATIONAL GROUP INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED BALANCE SHEETS (in 000’s, except for per share amounts)

The accompanying notes are an integral part of these unaudited interim condensed consolidated financial statements

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January 31, 2020 July 31, 2019

ASSETS

Current

Cash $ 7,080 $ 5,448

Accounts receivable 8,234 12,522

Non-hedging financial derivatives (Note 5) -- 25

Work-in-progress 10,885 8,605

Prepaid expenses and other current assets

Embedded derivative (Note 7)

1,302

12

1,286

24

27,513 27,910

Grants receivable (Note 15) 271 237

Capital assets (Note 6) 28,972 29,340

Deferred income taxes 3,138 2,864

$ 59,894 $ 60,351

LIABILITIES

Current

Bank indebtedness (Note 8) $ -- $ --

Accounts payable and accrued liabilities 3,358 3,417

Unearned revenue on work-in-progress 377 255

Non-hedging financial derivatives (Note 5) 3 --

Current portion of unearned revenue 19 47

Current portion of long-term debt (Note 9) 409 741

Long-term debt subject to demand provisions (Note 9) 6,061 6,244

10,227 10,704

Long-term debt (Note 9) 3,166 3,229

SHAREHOLDERS’ EQUITY

Share capital (Note 10) 18,394 18,531

Contributed surplus 1,843 1,820

Retained earnings 26,264 26,067

46,501 46,418

$ 59,894 $ 60,351

REKO INTERNATIONAL GROUP INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (in 000’s, except for per share amounts)


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Share capital Contributed surplus

Retained earnings

Accumulated other

comprehensive income

Total equity

Balance at July 31, 2018 $ 18,824 $ 1,865 $ 24,492 $ -- $ 45,181

Share-based payments 14 (20) -- -- (6)

Net income -- -- 442 -- 442

Balance at January 31, 2019 $ 18,838 $ 1,845 $ 24,934 $ -- $ 45,617

Balance at July 31, 2019 $ 18,531 $ 1,820 $ 26,067 $ -- $ 46,418

Share-based payments (137) 23 -- -- (114)

Net income -- -- 197 -- 197

Balance at January 31, 2020 $ 18,394 $ 1,843 $ 26,264 $ -- $ 46,501

REKO INTERNATIONAL GROUP INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (in 000’s, except for per share amounts)


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For the three months ended For the six months ended

January 31, 2020 January 31, 2019 January 31, 2020 January 31, 2019

Sales $ 9,538 $ 11,615 $ 18,888 $ 23,053 Costs and expenses Cost of sales 7,604 9,098 14,503 17,848 Depreciation 933 939 1,866 1,835

8,537 10,037 16,369 19,683

Gross profit 1,001 1,578 2,519 3,370 Selling and administrative 1,226 1,395 2,463 2,703

Income before other items (225) 183 56 667

Foreign exchange (gain) loss (171) (232) (10) (107) Other income (89) (26) (102) (52) (Gain) loss on sale of capital assets 3 -- 3 (2) Interest on long-term debt 90 104 188 209 Interest on other interest-bearing obligations 9 5 15 45

(158) (149) 94 93

Income before income taxes (67) 332 (38) 574 Deferred income tax (recovery) provision (124) 60 (235) 132

Net income and comprehensive income $ 57 $ 272 $ 197 $ 442

Earnings per common share (Note 12) Basic $ 0.01 $ 0.04 $ 0.03 $ 0.07

Diluted $ 0.01 $ 0.04 $ 0.03 $ 0.07

REKO INTERNATIONAL GROUP INC. UNAUDITED INTERIM CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (in 000’s, except for per share amounts)

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For the six months ended

January 31, 2020

For the six months ended

January 31, 2019

OPERATING ACTIVITIES Net income for the period $ 197 $ 442 Adjustments for: Depreciation 1.866 1,835 Income tax expense Interest expense

(235) 203

132 254

Change in value of embedded derivative 12 10 Change in non-hedging financial derivatives 28 -- Unrealized foreign exchange gain (loss) (4) 25 Share-based compensation 23 48 Gain on sale of capital assets 3 (2)

2,093 2,744 Net change in non-cash working capital 1,988 2,983 Interest paid (203) (256)

CASH PROVIDED BY OPERATING ACTIVITIES 3,878 5,446

FINANCING ACTIVITIES Proceeds from bank indebtedness -- (3,815) Proceeds from issuance of capital stock (137) (55) Change in grant receivable (34) 199 Payments on long-term debt (574) (558)

CASH USED IN FINANCING ACTIVITIES (745) (4,229)

INVESTING ACTIVITIES Investment in capital assets. Proceeds from sale of capital assets

(1,501) --

(1,296) 2

CASH USED IN INVESTING ACTIVITIES (1,501) (1,294)

Net change in cash 1,632 (52) Cash, beginning of period 5,448 6,565

Cash, end of period $ 7,080 $ 6,513

REKO INTERNATIONAL GROUP INC. NOTES TO UNAUDITED INTERIM CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (in 000’s, except for per share amounts)

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1. SIGNIFICANT ACCOUNTING POLICIES

Nature of operations

Reko International Group Inc. (the “Company” or “Reko”) is a diversified, technology-driven manufacturing organization located in Southwestern Ontario with areas of expertise including robotic factory automation solutions, precision machining of large, critical parts, and plastic injection and low compression acoustic tooling. The Company, incorporated under the laws of Ontario, has several subsidiaries, which operate or exist in the Province of Ontario in Canada and the State of Michigan in the United States.

Reko is listed on the TSX Venture Exchange under the symbol REKO. The Company’s shares are traded in Canadian dollars. The registered head office is located at 469 Silver Creek Industrial Drive, Lakeshore, Ontario, Canada.

All amounts are in thousands and in Canadian dollars, unless otherwise noted.

Statement of compliance

The unaudited interim condensed consolidated financial statements were authorized for issue by the Board of Directors on March 5, 2020.

These unaudited interim condensed consolidated financial statements have been prepared in accordance with IFRS as issued by the International Accounting Standards Board (“IASB”) applicable to the preparation of interim financial statements, including IAS 34 Interim Financial Reporting.

These unaudited interim condensed consolidated financial statements should be read in conjunction with the Company’s annual financial statements for the year ended July 31, 2019, which have been prepared in accordance with IFRS as issued by the IASB.

The accounting policies adopted are consistent with the accounting policies and methods as those used in the Company’s audited consolidated annual financial statements for the year ended July 31, 2019 except as noted below.

Basis of measurement

These consolidated financial statements were prepared on a going concern basis, under the historical cost convention, as modified by the revaluation of financial assets and financial liabilities (including derivative instruments) at fair value.

Basis of consolidation

Subsidiaries are entities controlled by the Company. Control exists when the Company has the power, directly or indirectly, to govern the financial and operating policies of an entity and be exposed to the variable returns from its activities. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control commences until the date that control ceases.

Intragroup balances, and any unrealized gains and losses or income and expenses arising from intragroup transactions, are eliminated in preparing the consolidated financial statements. Unrealized gains arising from transactions with jointly controlled entities are eliminated to the extent of the Company’s interest in the entity. Unrealized losses are eliminated in the same way as unrealized gains, but only to the extent that there is no evidence of impairment.


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The Company’s subsidiaries are as follows:

Subsidiary Location Percentage ownership

Consolidation

Concorde Precision Machining Inc. Ontario 100% Full

Reko Manufacturing Group Inc. Ontario 100% Full

Reko International Holdings, Inc. Michigan 100% Full

Reko International Services, Inc. Michigan 100% Full

Concorde USA LLC Michigan 100% Full

Leases

At inception or on reassessment of a contract that contains a lease component, the Company allocates the consideration in the contract to each lease component on the basis of their relative stand-alone price.

The Company recognizes a right-of-use asset and a lease liability at the lease commencement date. The right-of-use asset is initially measured at cost, which comprises the initial amount of the lease liability adjusted for any lease payments made at or before the commencement date, plus any initial direct costs incurred and an estimate of costs to dismantle and remove the underlying asset or to restore the underlying asset or the site on which it is located, less any lease incentives received.

The right-of-use asset is subsequently depreciated using the straight-line method from the commencement date to the earlier of the end of the useful life of the right-of-use asset or the end of the lease term. The estimated useful lives of right-of-use assets are determined on the same basis as those of property, plant and equipment. In addition, the right-of-use asset is periodically reduced by impairment losses, if any, and adjusted for certain remeasurements of the ease liability.

The lease liability is initially measured at the present value of the lease payments that are not paid at the commencement date, discounted using the interest rate implicit in the lease or, if that rate cannot be readily determined, the Company’s incremental borrowing rate.

The lease liability is measured at amortized cost using the effective interest method. It is remeasured when there is a change in future lease payments arising from a change in the relevant index or rate, if there is a change int the Company’s estimate of the amount expected to be payable under a residual value guarantee, or if the Company changes its assessment of whether it will exercise a purchase, extension or termination option.

2. CHANGES IN ACCOUNTING POLICIES_____________________________________________________________________

IFRS 16 Leases

Effective for interim and annual financial statements relating to fiscal years beginning on or after January 1, 2019, the IASB issued IFRS 16, Leases, to supersede IAS 17, Leases. This new standard provides a comprehensive model for the identification of lease arrangements and their treatment in the financial statements of both lessees and lessors. IFRS 16 applies a control model to the identification of leases, distinguishing between leases and service contracts on the basis of whether there is an identified asset controlled by the customer. Significant changes to lessee accounting are introduced, with the distinction between operating and finance leases removed and assets and liabilities recognized in respect of all leases (subject to limited exceptions for short-term leases and leases of low value assets).

The Company has adopted IFRS 16 with an effective date of August 1, 2019 using the modified retrospective approach. This adoption has resulted in an increase to capital assets of $39.

The main changes to lease accounting as a result of IFRS 16 includes:


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The definition of a lease has changed under the new standard. Under IFRS 16, a contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.

Under IFRS 16, the lessee recognizes a right-of-use asset and a lease liability upon lease commencement for leases with a lease term of greater than one year. The right-of-use asset is initially measured at the amount of the lease liability plus any initial directs costs incurred by the lessee. Subsequent measurement is determined based on the nature of the underlying asset. The lease liability is initially measured at the present value of the lease payments payable over the lease term and discounted at the implied lease rate. If the implied lease rate cannot be determined, the lessee uses its incremental borrowing rate. Previously, the Company classified leases as operating or finance leases based on its assessment of whether the lease transferred significantly all of the risks and rewards incidental to ownership of the underlying asset to the Company.

IFRS 16 provides detailed guidance on determining the lease term when the company has an option to extend the lease.

The new standard includes extensive disclosure requirements that differ from previous requirements.

On transition to IFRS 16, for leases previously classified as finance leases under IAS 17, the Company elected to apply the practical expedient whereby the Company is not required to reassess whether a contract is, or contains, a lease at the date of initial application. As such, the Company applied IFRS 16 only to contracts that were previously identified as leases.

The Company also adopted the recognition exemptions permitted for short-term leases and leases for which the underlying asset has a low value, as well as the following practical expedients permitted on initial adoption, under the standard:

Applying a single discount rate to a portfolio of leases with similar characteristics;

Using the Company’s previous assessment of impairment under IAS 37 “Provisions, Contingent Liabilities and contingent Assets” for onerous contracts instead of re-assessing the right-of-use asset for impairment on August 1, 2019;

Accounting for leases with a remaining term of less than 12 months as at August 1, 2019 as short-term leases;

Excluding initial directs costs from the measurement of the right-of-use asset at the date of initial application; and

Using hindsight in determining the lease term where the contract contains terms to extend or terminate the lease.

3. GEOGRAPHIC INFORMATION

The following information reflects the geographic breakdown of revenues and capital assets based on the physical location of the Company’s operations. The Company does not track revenues based on ship to locations.

Six months ended January 31, 2020

Revenues Capital assets

Canada $ 18,883 $ 28,972

United States 5 --

$ 18,888 $ 28,972

Six months ended January 31, 2019

Revenues Capital assets

Canada $ 22,936 $ 30,720

United States 117 --

$ 23,053 $ 30,720

4. FINANCIAL INSTRUMENTS

The Company’s financial instruments consist of cash, accounts receivable, non-hedging financial derivatives, embedded derivative, bank indebtedness, accounts payable and accrued liabilities and long-term debt.


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Fair Value

The Company has determined the estimated fair value of its financial instruments based on appropriate valuation methodologies; however, considerable judgment is required to develop these estimates. Accordingly, these estimated fair values are not necessarily indicative of the amounts the Company could realize in a current market exchange. The estimated fair value amounts can be materially affected by the use of different assumptions or methodologies. The methods and assumptions used to estimate the fair value of financial instruments are described below:

Accounts receivable, bank indebtedness, accounts payable and accrued liabilities

Due to the short period of maturity of the instruments, the carrying values as presented in the consolidated balance sheets are reasonable estimates of fair value.

Fair value hierarchy

The following table provides an analysis of cash, non-hedging financial derivatives, embedded derivatives and long-term debt that are measured subsequent to initial recognition at fair value, grouped into Levels 1 to 3 based on the degree to which the fair value is observable.

Level 1 fair value measurements are those derived from quoted prices (unadjusted) in active markets for identical assets or liabilities;

Level 2 fair value measurements are those derived from inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices); and,

Level 3 fair value measurements are those derived from valuation techniques that include inputs for the asset or liability that are not based on observable market data (unobservable inputs).

Level 1 Level 2 Level 3

January 31, 2020

Financial assets at FVTPL

Cash $ 7,080 $ -- $ -- $ 7,080

Embedded derivative -- 12 -- 12

$ 7,080 $ 12 $ -- $ 7,092

Level 1 Level 2 Level 3

July 31, 2019

Financial assets at FVTPL

Cash $ 5,448 $ -- $ -- $ 5,448

Non-hedging financial derivative -- 25 -- 25

Embedded derivative -- 24 -- 24

$ 5,448 $ 49 $ -- $ 5,497

Non-hedging financial derivatives

The Company’s non-hedging financial derivatives are the Company’s future forward exchange contracts and are subject to fluctuations in foreign exchange rates between the Canadian and US dollar. The Company’s non-hedging financial derivatives are valued based on discounting the future cash outflows associated with the contract based on the closing foreign exchange rate between the Canadian and US dollar.


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Embedded derivative

The Company’s embedded derivative relates to a provision in a long-term supply agreement with a customer. The provision provides that at the end of each six-month period in the five-year contract, the average foreign exchange rate between US dollars and Canadian dollars, during that period, shall be at least $1.09. In the event the average foreign exchange rate is less than $1.09, the customer equalizes the Company based on an average foreign exchange rate of $1.09. The Company’s embedded derivative is valued based on valuation models for Asian puts and the closing foreign exchange rate between the Canadian and US dollar.

Long-term debt

The Company’s long-term debt of CDN $6,032 and USD $2,791 (currently valued at CDN $3,667) is subject to fixed interest rates. The Company’s long-term debt is valued based on discounting the future cash outflows associated with the long-term debt. The discount rate is based on the incremental premium above market rates for Government of Canada securities of similar duration. In each period thereafter, the incremental premium is held constant while the Government of Canada security is based on the then current market value to derive the discount rate. At January 31, 2020, the fair value of the Company’s long-term debt is CDN $5,154 and USD $2,292 (currently valued at CDN $3,004). At January 31, 2019, Company’s long-term debt was CDN $6,300 and USD $2,941.

5. NON-HEDGING FINANCIAL DERIVATIVES

The Company utilizes financial instruments to manage the risk associated with fluctuations in foreign exchange. As at January 31, 2020, the Company had entered into foreign exchange contracts to sell an aggregate amount of $1,000 (USD). These contracts mitigate the Company’s expected exposure to U.S. dollar denominated net assets and mature at, the latest, February 13, 2020, at an average exchange rate of $1.3195 Canadian. The mark-to-market value on these financial instruments as at January 31, 2020 was an unrealized loss of $3, which has been recorded in net income for the period.

As at January 31, 2019 Maturity Notional value

Average rate

Notional USD

equivalent

Carrying & fair value (liability)

asset

Sell USD / Buy CAD 0 – 6 months $ 997 1.3195 $ 1,000 $ (3)

As at July 31, 2019 Maturity Notional value

Average rate

Notional USD

equivalent

Carrying & fair value (liability)

asset

Sell USD / Buy CAD 0 – 6 months $ 7,025 1.3220 $ 7,000 $ 25

6. CAPITAL ASSETS

Capital assets are comprised of:

Land Buildings Machinery and

equipment

Leasehold improvements

Equipment under

construction

Total

Cost or deemed cost

Balance at July 31, 2018 $ 661 $ 13,650 $ 50,193 $ 587 $ 2,211 $ 67,302

Additions -- 134 -- -- 1,688 1,822

Transfers -- 313 3,176 224 (3,713) --

Disposals -- -- (63) -- -- (63)

Balance at July 31, 2019 $ 661 $ 14,097 $ 53,306 $ 811 $ 186 $ 69,061

Additions -- 49 39 -- 1,413 1,501

Transfers -- -- 773 33 (806) --

Disposals -- -- (11) -- -- (11)


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Balance at January 31, 2020 $ 661 $ 14,146 $ 54,107 $ 844 $ 793 $ 70,551

68,966

Land Buildings Machinery and

equipment

Leasehold improvements

Equipment under

construction

Total

Amortization and impairment losses

Balance at July 31, 2018 $ -- $ 4,100 $ 31,693 $ 250 $ -- $ 36,043

Amortization for the year -- 470 3,214 46 -- 3,730

Disposals -- -- (52) -- -- (52)

Balance at July 31, 2019 $ -- $ 4,570 $ 34,855 $ 296 $ -- $ 39,721

Amortization for the year -- 236 1,600 30 -- 1,866

Disposals -- -- (8) -- -- (8)

Balance at January 31, 2020 $ -- $ 4,806 $ 36,447 $ 326 $ -- $ 41,579

Carrying value

Balance at July 31, 2019 $ 661 $ 9,527 $ 18,451 $ 515 $ 186 $ 29,340

Balance at January 31, 2020 $ 661 $ 9,340 $ 17,660 $ 518 $ 793 $ 28,972

Net book value of right of use assets as at August 1, 2019

-- -- $39 -- -- $39

Net book value of right of use assets as at January 31, 2020

-- -- $36 -- -- $36

7. EMBEDDED DERIVATIVE

During the first quarter of 2015, the Company entered into a long-term supply agreement with one of its customers. One of the terms of that agreement included an embedded derivative, establishing a foreign exchange rate floor of $1.09 on sales by the Company to the customer. This floor is measured every six months during the term of the agreement and is based on the average foreign exchange rate during the period under measurement.

The embedded derivative is comprised of:

January 31, 2020

July 31, 2019

Embedded derivative, beginning of year $ 24 $ 48

Fair value change, during the period (12) (24)

Embedded derivative, end of period $ 12 $ 24

8. BANK INDEBTEDNESS

The bank indebtedness is payable over various maturities, not exceeding 30 days, with interest at various amounts ranging from LIBOR plus 175 basis points to bank prime plus 50 basis points, as follows:

January 31, 2020

July 31, 2019

Bank overdraft – bearing interest at 5.25% $ -- $ --

Canadian dollar bankers’ acceptance bearing interest at 2.30% due in less than 30 days

--

--

U.S. dollar LIBOR bearing interest at 3.63% due in less than 30 days -- --

Foreign exchange on U.S. dollar LIBOR -- --

$ -- $ --


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The bank indebtedness is secured by a general assignment of book debts and work-in-progress together with a second collateral mortgage of $8,500 on all land and buildings. At January 31, 2020, the Company’s available operating lines of credit of $15,886 was fully available based on lender defined margining capabilities.

9. LONG-TERM DEBT

The long-term debt is comprised of:

January 31,

2020

July 31,

2019

Mortgage payable – 3.97%, repayable $21 monthly including interest,

due in full April 2023, secured by certain land and building and an

assignment of rents on the subject property $ 3,292 $ 3,352

Mortgage payable – 4.42%, repayable $21 monthly including interest,

due in full August 2023, secured by certain land and building and

general security agreement, subject to demand provisions 2,741 2,815

Mortgage payable – 3.06% plus a credit spread, which may vary over

the life of facility to a maximum of 275, currently at 175 for an all-in

rate of 4.81%, repayable USD $14 monthly plus interest, due in full

August 2025, secured by certain land, buildings and a general

security agreement, subject to demand provisions 3,667 3,778

Loan payable – US dollar LIBOR (USD $800) plus applicable margin

from 175 to 250 basis points, USD $45 monthly plus interest, due in

full in March 2020, secured by general assignment of book debts and

work-in-progress, together with a collateral mortgage, subject to

demand provisions -- 342

9,700 10,287

Deduct - unamortized finance fees 64 73

- principal portion included in current liabilities 6,470 6,985

Long-term portion $ 3,166 $ 3,229

Notwithstanding the fact that certain facilities listed above are subject to demand provisions and are classified as current liabilities as a result, the Company expects to repay the principal over the entire scheduled term of the loans and these payments are outlined below. At January 31, 2020, $473 is due within the next twelve months under normal repayment terms and an additional $6,061 is not expected to be due in the next year but is subject to demand provisions.

Total bank credit facilities are as follows:

Year

Bank Credit

Facilities

Next 12 months $ 473

2 years 478

3 years 484

4 years 3,247

5 years 2,340


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Thereafter 2,678

Balance of obligation $ 9,700

10. SHARE CAPITAL

Share capital is comprised of:

Authorized Issued Shares Amount

Class A preference shares Unlimited Nil $ --

Class B preference shares Unlimited Nil --

Common shares – no par value Unlimited 6,312,750 $ 18,394

Share capital transactions during the period were as follows:

January 31, 2020 July 31, 2019

Shares Amount Shares Amount

Outstanding, beginning of year 6,351,620 $ 18,531 6,439,920 $ 18,824

Transactions during the period (38,870) (137) (88,300) (293)

Outstanding, end of period 6,312,750 $ 18,394 6,351,620 $ 18,531

The following table presents the maximum number of shares that would be outstanding if all the dilutive “in the money” instruments outstanding, as at January 31, 2020 were exercised:

Common shares outstanding at January 31, 2020 6,312,750

Stock options 79,740

6,392,490

11. CONTRIBUTED SURPLUS

Contributed surplus is comprised of:

January 31, 2020

July 31, 2019

Balance, beginning of period $ 1,820 $ 1,865

Amounts in respect of exercised stock options 23 (69)

Amounts in respect of the stock-based compensation -- 24

Balance, end of period $ 1,843 $ 1,820

12. EARNINGS PER SHARE

The calculation of basic earnings per share at January 31, 2020 was based on the net income attributable to common shareholders of $197 and a weighted average number of common shares outstanding of 6,341,607 calculated as follows:

January 31, 2020

January 31, 2019

Basic earnings per share:

Net income for the three-month period $ 57 $ 272

Average number of common shares outstanding during the period

6,349,263

6,451,498

Basic earnings per share $ 0.01 $ 0.04


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Diluted earnings per share:

Net earnings available to common shareholders $ 57 $ 272


6,349,263

6,451,498

‘In the money’ stock options outstanding during the period 79,740 313,000

6,659,133 6,764,498

Diluted earnings per share $ 0.01 $ 0.04

January 31,

2020 January 31,

2019

Basic earnings per share:

Net income for the six-month period $ 197 $ 442


6,341,607

6,449,994

Basic earnings per share $ 0.03 $ 0.07

Diluted earnings per share:

Net earnings available to common shareholders $ 197 $ 442


6,341,607

6,449,994

‘In the money’ stock options outstanding during the period 79,740 313,000

6,421,347 6,762,994

Diluted earnings per share $ 0.03 $ 0.07

13. STOCK-BASED COMPENSATION

The Company has established a stock option plan for directors, officers and key employees. The terms of the plan state that the aggregate number of shares, which may be issued and sold, will not exceed 10% of the issued and outstanding common shares of the Company on a non-diluted basis. The issue price of the shares shall be determined at the time of grant based on the closing market price of the shares on the specified date of issue. Options shall be granted for a period of five years. At the directors’ discretion, the vesting progression is 30% in the year of grant, 30% in the second year after grant and 40% in the third year after the grant. Options given to outside directors vest immediately and can be exercised immediately.

As at January 31, 2020, the following options were outstanding:

Number of Options Exercise price Expiry

90,000 $ 3.90 2022

107,900 $ 2.90 2024

10,000 $ 3.50 2025


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The weighted average of the options is as follows:

January 31, 2020 January 31, 2019

Number of

Options

Weighted Average

Exercise Price

Number of Options

Weighted Average Exercise

Price

Outstanding at the beginning of the period 462,000 $ 2.60 401,000 $ 2.46

Expired during the period (253,470) $ 2.00 -- --

Issued during the period 10,000 $ 3.50 120,000 $ 2.90

Exercised during the period (630) $ 2.90 (30,000) $ 1.15

Cancelled during the period (10,000) $ 3.16 -- --

Outstanding at the end of the period 207,900 $ 3.36 491,000 $ 2.66

Exercisable at the end of the period 79,740 $ 2.93 57,000 $ 2.90

The description of the method and significant assumptions used during the year to estimate the fair values of options, including the weighted average information, is as follows:

January 31, 2020

January 31, 2019

Expected life 5 years 5 years

Expected dividends $ Nil $ Nil

Expected volatility – based on a 60-month historical average 38.81% 45.59%

Risk free rate of return 0.14% 0.69%

Expected forfeiture rate 100.0% 93.0%

Total compensation cost recognized in income for stock-based employee compensation awards

$ --

$ 48

14. RELATED PARTY TRANSACTIONS

Transactions with key management personnel

In addition to their salaries, the Company also provides non-cash benefits to its executive officers and contributes to a post-employment defined contribution benefit plan on their behalf. In accordance with the terms of the plan, executive officers are entitled to a receive a $1 contribution to the Company’s Group RRSP annually, once they have completed 5 years of service to the Company (or as otherwise, negotiated). During the period, the Company expensed contributions of less than $1 to the defined contribution plan in Canada. The above contribution plans are identical to the contribution plans provided to all Canadian employees of the Company of key management personnel.

Executive officers are also eligible, as are all employees, to participate in the Company’s share option programme.

Key management personnel compensation comprised:

January 31, 2020 January 31, 2019

Salaries and cash bonuses $ 338 $ 340

Short-term employment benefits 11 14

Post-employment benefits 1 2

$ 350 $ 356

Key management personnel and director transactions

Directors of the Company control 3.7% of the voting shares of the Company. Relatives of a director own, directly or indirectly, 61.37% of the voting shares of the Company.


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15. GOVERNMENT GRANT

Effective August 1, 2017, the Company entered into a contract with the Ontario Ministry of Economic Growth and Development to receive funding of $300 per year for five successive years under the Southwestern Ontario Development Fund (SWODF). The contract provides a non-repayable grant in the amount of 10% of approved capital expenditures incurred in connection with the expansion of the Company’s manufacturing capabilities during the period from May 1, 2017 through July 31, 2021 and is contingent upon the Company meeting agreed upon job creation targets.

The funding relates primarily to capital acquisitions and as a result, related assets are recorded net of the applicable grant amount - with the net amount being amortized over the useful life of each individual asset.

As of January 31, 2020, the Company has received $600 in cash funding from SWODF and accrued an additional amount receivable of $571 on total eligible expenditures of $11,707. The current portion of $300 is included in accounts receivable with the remainder of $271 being disclosed as long-term grant receivable at January 31, 2020. Grant amounts will be paid in accordance with the funding contract over the period of the agreement as long as job creation targets and certain reporting and other obligations are fulfilled on an annual basis.

REKO INTERNATIONAL GROUP INC. MANAGEMENT’S DISCUSSION AND ANALYSIS

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MANAGEMENT’S DISCUSSION AND ANALYSIS

The following is management’s discussion and analysis of operations and financial position (“MD&A”) and should be read in conjunction with the unaudited interim condensed consolidated financial statements for the period ended January 31, 2020 and the audited consolidated financial statements and MD&A for the year ended July 31, 2019 included in our 2019 Annual Report to Shareholders. The unaudited interim condensed consolidated financial statements for the period ended January 31, 2020 have been prepared in accordance with International Financial Reporting Standards (“IFRS”). When we use the terms “we”, “us”, “our”, “Reko”, or “Company”, we are referring to Reko International Group Inc. and its subsidiaries. This MD&A contains forward-looking information and forward-looking statements within the meaning of applicable securities laws. We use words such as “anticipate”, “plan”, “may”, “will”, “should”, expect”, “believe”, “estimate” and similar expressions to identify forward-looking information and statements. Such forward-looking information and statements are based on assumptions and analyses made by us in light of our experience and our perception of historical trends, current conditions and expected future developments, as well as other factors we believe to be relevant and appropriate in the circumstances. Readers are cautioned not to place undue reliance on forward-looking information and statements, as there can be no assurance that the assumptions, plans, intentions or expectations upon which such statements are based will occur. Forward-looking information and statements are subject to known and unknown risks, uncertainties, assumptions and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed, implied or anticipated by such information and statements. These risks are described in the Company’s MD&A and, from time to time, in other reports and filings made by the Company with securities regulators.

While the Company believes that the expectations expressed by such forward-looking information and statements are reasonable, there can be no assurance that such expectations and assumptions will prove to be correct. In evaluating forward-looking information and statements, readers should carefully consider the various factors, which could cause actual results or events to differ materially from those, indicated in the forward-looking information and statements. Readers are cautioned that the foregoing list of important factors is not exhaustive. Furthermore, the Company disclaims any obligations to update publicly or otherwise revise any such factors of any of the forward-looking information or statements contained herein to reflect subsequent information, events or developments, changes in risk factors or otherwise.

This MD&A has been prepared by reference to the MD&A disclosure requirements established under National Instrument 51-102 “Continuous Disclosure Obligations” (“NI 51-102”) of the Canadian Securities Administrators. Additional information regarding Reko International Group Inc. is available on our website at www.rekointl.com or through the SEDAR website at www.sedar.com.

In this MD&A, reference is made to earned revenue, which is not a measure of financial performance under IFRS. The Company calculates earned revenue as sales less materials, sub-contracting and inventory adjustments. The Company included information concerning this measure because it is used by management as measure of performance, and management believes it is used by certain investors and analysts as a measure of the Company’s financial performance. This measure is not necessarily comparable to similarly titled measures used by other companies.

All amounts in this MD&A are expressed in 000’s of Canadian dollars, except per share amounts and where otherwise indicated.

This MD&A is current to March 5, 2020.

OVERVIEW

Reko International Group Inc. is a diversified, technology-driven manufacturing organization. Our touchstone philosophy is “Strengthening Communities by Advancing Manufacturing” which epitomizes our commitment to using our distinctive blend of technology and skills to improve the lives of our team members, our customers, our shareholders, as well as our local and global communities.

Reko designs and manufactures a variety of engineered products and services for original equipment manufacturers (“OEMs”) and their Tier suppliers. These products include design and construction of unique specialty machines and lean cell factory automation solutions and robotics; high precision, custom machining of very large critical components and assemblies; and plastic injection and low compression acoustic molds. While many of our customers are in the automotive market, the Company has diversified beyond automotive into a number of sectors.

For the transportation and oil and gas industries, the Company machines customer supplied metal castings to customer indicated specifications. For the automotive industry, the Company conceptualizes, designs and builds innovative solutions to manufacturing challenges, including specialty machines for gas tank assembly lines; unique material handling applications; work cell solutions as well as compression molds and plastic injection molds. Across our target industries, Reko is known for

http://www.rekointl.com/

http://www.sedar.com/


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outstanding quality and customer focus and for an unwavering commitment to exceeding customer expectations and deliverables while striving for constant improvement across all our chosen metrics.

Our design and manufacturing operations are carried on in three manufacturing plants located on adjacent parcels of land in Lakeshore, Ontario – a suburb of the City of Windsor in Southwestern Ontario. This includes a new state of the art automation facility which was opened in April 2018.

RECONCILIATION OF NON-IFRS MEASURES

The reconciliation of earned revenue to sales is provided in the following table:

Three months ended Six months ended

January 31, 2020 January 31, 2019 January 31, 2020 January 31, 2019

Sales $ 9,538 $ 11,615 $ 18,888 $ 23,053 Less: Materials 2,439 3,472 4,392 6,743 Sub-contracting 387 449 886 1,286 Inventory adjustments 359 33 (15) (85)

$ 6,353 $ 7,661 $ 13,625 $ 15,109

RESULTS OF OPERATIONS

Sales

Sales for the three months ended January 31, 2020 decreased $2,077, or 17.3%, to $9,538, compared to $11,615 in the same period in the prior year. Sales for the six months ended January 31, 2020 decreased $4,165, or 18.1%, to $18,888, compared to $23,053 in the same period in the prior year.

The decrease is primarily driven by continued lower volumes in certain sectors. Certain divisions also experienced a delayed timing of kick off and completion for certain jobs, which impacted results in both quarters. The decrease was partially offset by an increase in foreign exchange rates for U.S. dollar sales.

Earned revenue

Earned revenue is not a standard IFRS measurement. The Company’s explanation of how it measures earned revenue is located in the previous section. Earned revenue effectively measures that portion of our total revenue available to the Company to pay its workers, pay for its fixed and operating costs and earn a profit. The Company believes that earned revenue is a more effective measurement of how the Company is performing.

For the three months ended January 31, 2020, earned revenue decreased by 17.1%, to $6,353 compared to $7,661 in the same period in the prior year. For the six months ended January 31, 2020, earned revenue decreased by 9.8%, to $13,625 compared to $15,109 in the same period in the prior year. The decrease in earned revenue is due to the overall decrease in revenue.

Gross profit

The gross profit for the three months ended January 31, 2020 decreased $577, or 36.6%, to $1,001, compared to $1,578 in the same period in the prior year. Gross profit for the six months ended January 31, 2020 decreased $851, or 25.3%, to $2,519, compared to $3,370 in the same period in the prior year. The decreased overall sales had an impact on gross profit. As a percentage of sales at 10.5%, gross profit has experienced a decrease during the second quarter. This is mainly due to some additional manpower required on some specialized work to meet customer requirements. Overall, for the six months of the current fiscal year, gross profit as a percentage of sales of 13.3%, compared to 14.6% for the same period last fiscal year, remains relatively consistent.

Selling and administration


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Selling and administration expenses (“S&A”) decreased by $169 to $1,226 for the three months ended January 31, 2020, compared to $1,395 for the same period in the prior year. S&A for the six months ended January 31, 2020 decreased by $240 to $2,463 compared to $2,703 for the same period last fiscal year. The Company continues to monitor spend and has implemented several cost reduction initiatives during the fiscal year.

Earnings overview

The net income for the three months ended January 31, 2020 was $57, or $0.01 per share, compared to a net income of $272, or $0.04 per share, in the same period of the prior year. For the six months ended January 31, 2020, net income was $197, or $0.03 per share, compared to $442, or $0.07 per share, in the same period last year.

LIQUIDITY AND CAPITAL RESOURCES

Cash flow provided by operations for the period was $3,878 as compared to $5,446 in the same period of the previous year. The decrease in cash flow provided by operations is primarily a result of a decrease in the net change in non-cash working capital.

Financial covenants

The Company continues to meet its financial covenants, including the first quarter of 2020.

The Company believes it has sufficient operating room with respect to its financial covenants for the next fiscal year and does not anticipate being in breach of any of its financial covenants during this period.

Capital assets and investment spending

For the six months ended January 31, 2020, the Company invested $1,501 in capital assets.

Cash resources/working capital requirements

As at January 31, 2020, Reko had cash on hand of $7,080, compared to $5,448 at July 31, 2019, and compared to $6,513 at January 31, 2019.

At January 31, 2020 the Company did not have any outstanding bank indebtedness. Reko has a $20,000 revolver available. At October 31, 2019, the Company’s available operating lines of credit of $15,886 was fully available based on lender defined margining capabilities.

Contractual obligations and off-balance sheet financing

Payments due by period

Contractual obligations Total Less than 1

year 1 – 3 years 4 – 5 years After 5 years

Long-term debt $ 3,290 $ 124 $ 267 $ 2,899 --

Long-term debt subject to demand provisions 6,406* $ 349* $ 695* $ 2,687* $ 2,675*

Lease liabilities 36 9 19 8

Total contractual obligations $ 9,732 $ 482 $ 981 $ 5,594 $ 2,675

Except as disclosed elsewhere in this MD&A, there have been no material changes with respect to the contractual obligations of the Company during the year.


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Amounts denoted by an asterisk (*) are subject to demand provisions in that the lender is contractually entitled to require payment of the outstanding balance “on demand”. The Company is in receipt of correspondence from the lender indicating that there is no expectation that the balances will be called within the next twelve months and it is anticipated that principal and interest payments on these facilities will be made as scheduled throughout the term of the loans. These scheduled payments are reflected in the table above.

Reko does not maintain any off-balance sheet financing.

Share capital

The Company had 6,312,750 common shares outstanding at January 31, 2020.

Outstanding share data

Designation of security Number outstanding

Maximum number issuable if convertible, exercisable or exchangeable for common

shares

Common Shares 6,312,750 Stock options issued 207,900

Stock options exercisable 79,740

Total (maximum) number of common shares 6,600,390

INDUSTRY TRENDS AND RISKS

While the Company has increased the level of diversification across industries, sales volumes still have a significant dependence upon the levels of new model releases for vehicles by OEMs and on the construction, expansion or retooling of production facilities and our ability to secure tooling and automation programs as a result of these activities through their Tier suppliers. New model releases and production expansion/retooling in the automotive sector can be impacted by many factors, including general economic and political conditions, interest rates, energy and fuel prices, labour relations’ issues, regulatory requirements, infrastructure, legislative changes, environmental emissions, safety considerations and changing technologies. The Company’s sales levels are also impacted by demand levels in the transportation and oil and gas sectors. Demand in these areas can be

affected by many factors, including general economic and political conditions, interest rates, energy and fuel prices, regulatory requirements, transportation infrastructure and safety issues.

The economic, industry and risk factors discussed in our Annual Report, each in respect of the year ended July 31, 2019, remain substantially unchanged in respect of the six months ended January 31, 2020, however, the most significant of these are repeated below.

Current outsourcing and in-sourcing trends

During periods of weakened demand, our customers traditionally revisit outsourcing decisions as a method of maintaining their employment levels. Then, during periods of strong demand, they return to previous levels of outsourcing. As a result of this and other factors, our demand levels will swing with general economic activity related to the industries we serve. Depending on how the current economic climate impacts particular customers, Reko may experience reductions in outsourced work orders.

A shift away from technologies in which the Company is investing


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Like our OEM and Tier 1 and 2 customers, we continue to invest in technologies and innovations, which the Company believes are critical to long-term growth. Our ability to anticipate changes in technology and to successfully develop and introduce new and enhanced products on a timely basis using such technologies will be a significant factor in our ability to remain competitive. Current technological shifts in the industry would include the application of the Internet of Things, integration of additive manufacturing capabilities into our processes and the transition to electric and autonomous vehicles. If there is a movement away from the use of specific technologies that the Company is focused on developing or someone applies these technologies more quickly or effectively, our costs may not be fully recovered. In addition, if other technologies in which our investment is not as great, or our expertise is not as fully developed emerge as the industry-leading technologies, we may be placed at a competitive disadvantage, which could have a material adverse effect on our profitability and financial condition. Management continually monitors the emergence of new technologies and updates our investments in these emerging technologies accordingly.

Diversification of our sales

Although we supply factory automation, molds, gauges, and fixtures to all the leading automobile manufacturers, a majority of our sales are still to the Detroit 3. In addition, although we supply machined locomotive crankcases to each of the leading locomotive manufacturers, a significant majority of our sales in this sector are to one locomotive OEM. While we have diversified our customer base in recent years, and continue to attempt to further diversify, we may experience varying degrees of success. Inability to successfully grow our sales to non-traditional customers could have an adverse effect on our profitability and financial condition.

Challenges successfully competing against suppliers with operations in developing markets

Many of our customers have sought, and will likely continue to seek, to take advantage of lower operating costs in Mexico, China, India, Southeast Asia, and other developing markets. We continue to investigate opportunities to expand our manufacturing sources, with a view to taking advantage of these lower cost countries. However, we cannot guarantee that we will be able to fully realize such opportunities. The inability to quickly adjust our manufacturing sources to take advantage of opportunities in these markets could harm our ability to compete with our suppliers operating in or from such markets, which could have an adverse effect on our profitability and financial condition.

Continued support of our lenders

The Company operates in a capital-intensive business, has significant financing requirements placed on it by its customers, and our financial resources are, in many cases, less than the financial resources of our customer base. There can be no assurance that if and when the Company seeks additional equity or debt financing, it will be able to obtain the additional financial resources required to successfully compete in its markets on favourable commercial terms (or to obtain these resources at all). However, the Company maintains a strong relationship with a number of key lenders and keeps them apprised of, not only financial results, but also future plans and challenges. In the event that debt financing was not available at some future date, additional equity financings may result in dilution to existing shareholders.

Significant long-term fluctuations in relative currency values

Although, our financial results are reported in Canadian dollars, significant portions of our sales are realized in U.S. dollars. Movements in the U.S. dollar against the Canadian dollar affect our profitability. As a result of the purchase of appropriate amounts of forward exchange contracts, foreign currency transactions are not fully impacted by movements in exchange rates. Due to this program, our accounting risk (i.e. the risk associated with our foreign exchange balances on our balance sheet at any point in time) is reduced. This program does not necessarily reduce our economic risk (i.e. the risk associated with all our foreign exchange balances and potential balances regardless of whether those balances and potential balances are on our balance sheet at any one particular time). Despite these measures, significant long-term fluctuations in relative currency values could have an adverse effect on our profitability and financial condition and any sustained change could adversely impact our competitiveness.

Economic downturn triggered by potential global pandemic

The new coronavirus threat that originated in China has had a global effect. China’s economy, whose manufacturing and production sectors serve as a workshop for much of the world, has taken a severe hit. However, the effect has now expanded to global businesses, many of which are experiencing supply chain issues. The further spread of the virus to other countries has sparked growing concern that the situation has become a pandemic. Should the virus not be contained relatively soon,


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transport and import costs could rise. Should the virus expand its geographical reach, disruption to global trade demand and consumer spending would trigger a global recession.

FOREIGN EXCHANGE AND OTHER FINANCIAL INSTRUMENTS

Reko is exposed to the impacts of changes in the foreign exchange rate between Canadian and United States (“U.S.”) dollars. More specifically, approximately 85% of the Company’s sales and 20% of its costs are incurred in U.S. dollars. In addition, the Company maintains certain working capital balances in U.S. funds.

To minimize our exposure to the impacts of changes in the foreign exchange rate, the Company maintains a forward foreign exchange contract purchasing programme ("FFEC Programme”). Reko’s Programme is based on maintaining our approximate net exposure to the U.S. dollar (total U.S. exposure less forward foreign exchange contracts) between positive and negative $5,000. This Programme is designed to minimize the Company’s exposure to foreign exchange risks over the mid-term. During periods of rapid fluctuation in the foreign exchange rate between the Canadian dollar and the U.S. dollar, regardless of our net exposure to the U.S. dollar, the Company can generate significant gains or losses, which may materially impact financial results. These significant gains or losses are entirely related to mark-to-market accounting rules and represent the product of our net exposure to the U.S. dollar and the change during any given month of the value of the U.S. dollar in relation to the Canadian dollar.

During each of the last four quarters, the Company’s quarter-end exposure to the U.S. dollar has been:

Fiscal Period Total U.S. exposure before

hedging programme Forward foreign exchange

contracts booked Net exposure to the U.S.

dollar

Q2 - 2020

Q1 - 2020

Q4 – 2019

$ 7,772

$ 9,300

$ 11,639

$ 1,000

$ 4,000

$ 7,000

$ 6,772

$ 5,300

$ 4,639

Q3 – 2019 $ 13,897 $ 10,000 $ 3,897

As a result of the Company’s purchase of forward foreign exchange contracts (“FFECs”), the Company is subject to changes in foreign exchange rates that may not be consistent with changes in the current quoted foreign exchange rates. More specifically, the Company’s foreign exchange risk is split such that its net exposure to the U.S. dollar, as detailed above, is subject to changes in market foreign exchange rates on a monthly basis and the remainder of its U.S. dollar exposure is subject to foreign exchange risks based on the specific foreign exchange rate contained in its FFECs. The table below presents a comparison between actual foreign exchange rates and Reko’s effective rate on its booked FFECs.

The table below presents a comparison between actual foreign exchange rates and Reko’s effective rate on its booked FFECs.

For the three months ended January 31, 2020 For the six months ended January 31, 2020

2020 2019 2020 2019

Actual

Reko effective

rate Actual

Reko effective

rate Actual

Reko effective

rate Actual

Reko effective

rate


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U.S. Dollar equals Canadian Dollar 1.3153 1.3204

1.3299 1.3107

1.3197

1.3186

1.3162

1.3051

The Company’s FFECs represent agreements with an intermediary to trade a specific amount of U.S. dollars for Canadian dollars at a specific rate on a specific date. Currently, the date is between one (1) and six (6) months after the date on which the FFEC is booked. The specific rate entered into is not necessarily indicative of what either the intermediary or Reko believes the foreign exchange rate will be on the date the settlement of the trade occurs, rather it is a rate set by the intermediary which Reko can either accept or reject.

During the second quarter, the Company recorded a pre-tax gain of approximately $171 related to the fair value of its U.S. dollar exposures. At the end of the quarter, we held FFECs of $1,000 compared to $13,000 at the end of the quarter in the prior year. During fiscal 2020, on average, we held FFECs of $4,000, compared to $11,000 during the prior year.

The following table outlines the level of FFECs presently maintained and the average effective rate of these contracts:

Fiscal Period Contract value booked (000’s)

Effective average rate

Q2 - 2020 $ 1,000 1.3195

The Company notes that at current levels of FFECs and U.S. dollar denominated assets and liabilities, an increase in the value of the U.S. dollar against the Canadian dollar results in the Company recording gains and an increase in the value of the Canadian dollar against the U.S. dollar results in recording losses for the Company.

Foreign currency transactions are recorded at rates in effect at the time of the transaction. Forward exchange contracts are recorded at month-end at their fair value, with unrealized holding gains and losses recorded in foreign exchange gain (loss).

QUARTERLY RESULTS

The following table sets out certain unaudited financial information for each of the eight fiscal quarters up to and including the second quarter of fiscal 2020, ended January 31, 2020. The information has been derived from the Company’s unaudited consolidated financial statements, which in management’s opinion, have been prepared on a basis consistent with the audited consolidated financial statements contained elsewhere in the Annual Report for the year ended July 31, 2019, and include all adjustments necessary for a fair presentation of the information presented. Past performance is not a guarantee of future performance and this information is not necessarily indicative of results for any future period.

Apr/19 July/19 Oct/19 Jan/20

Sales $ 14,277 $ 10,659 $ 9,350 $ 9,538

Net income 609 526 140 57

Earnings per share: Basic 0.10 0.08 0.02 0.01

Diluted 0.09 0.07 0.02 0.01

Apr/18 July/18 Oct/18 Jan/19


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Sales $ 11,776 $ 10,206 $ 11,438 $ 11,615

Net income 647 713 170 272

Earnings per share: Basic 0.10 0.11 0.03 0.04

Diluted 0.10 0.10 0.03 0.04

NORMAL COURSE ISSUER BID

On December 27, 2019, the Company announced the extension of the normal course issuer bid. Under the plan, the Company may purchase on the TSX Venture Exchange up to a total of 316,933 of its common shares during the twelve-month period which commenced December 31, 2019. The 316,933 common shares represent approximately 5% of the total common shares outstanding. The price that the Company will pay for any such shares will be the market price at the time of acquisition and all shares acquired under the bid will be cancelled by the Company.

During the quarter ended January 31, 2020, Reko purchased and subsequently cancelled 31,800 shares under the provision of the normal course issuer bid.

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